This document is intended for investment professionals only and must not be relied on by anyone else
A Standard Life Investments presentation on
June 2011

 Basic Modern Portfolio Theory and The Efficient Frontier
 Strategic Asset Allocation
 Coffee Break
 Stochastic Modelling
 Tactical Asset Allocation
 Passive vs. Active
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• COBS 92.2R requires that firms must:
 Take into account t he customer’s preferences regarding risk taking

Take into account the customer’s risk profile
 Ensure that customers are able financially to bear risks
Source: http://www.fsa.gov.uk/pubs/guidance/gc11_01.pdf
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• However, the FSA finds that firms:
 Over-rely on risk profiling and asset allocation tools
 Poorly describe customer risk attitudes
 Poorly understand tools
Source: http://www.fsa.gov.uk/pubs/guidance/gc11_01.pdf
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• FSA’s recommendations:
 Firms should have a robust processing for assessing a customer’s willingness and ability to take risk
 Tools should be appropriate and limitations should be recognised

All aspects of a customer’s objectives and situation should be considered when making investment selections – not just risk
Source: http://www.fsa.gov.uk/pubs/guidance/gc11_01.pdf
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Key Issues
• FSA’s view on lack of attention to asset allocation
• FSA’s concerns over superficial treatment of risk
Objectives of today’s seminar
You will be in a better position to:
• Recommend a suitable investment strategy for clients
• Understand forecast returns on different portfolios
• Analyse the risk and return trade off
• Set more informed client expectations
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produce a stronger composite than any single element
Recognising and balancing tradeoffs including time horizon,
Capital preservation goals, and expected sources of return
Setting minimum and maximum constraints to ensure sufficient representation, but not overconcentration
Diversifying asset classes to align portfolio and individual risk/reward profiles and to be compensated for bearing non diversifiable volatility
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• Maximise expected return for a given amount of risk
• Or maximise risk for a given level of expected return
• Mathematical formulation of the concept of diversification in investing
• Aim is to select investment assets that collectively lower risk than any individual asset class
• Stock markets moving independently to bond markets
• By combining assets that are not perfectly correlated MPT seeks to reduce the total volatility of portfolio returns
• Assumes investors are rational and marks are efficient
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Focused on delivering superior performance return x x x x x x x x x x x x x x x x x x x x x risk
Individual asset risk and return profiles
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return
Beyond the curve reflects returns impossible under current conditions
High Risk and High
Return
Medium Risk and Medium
Return
Low Risk and Low Return
Below the curve reflects inefficient operations that may achieve greater returns elsewhere with the same risk risk
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Focused on delivering superior performance return x x x x x x x x x x x x x x x x x x x x x risk
An ‘efficient frontier’ from universe of selected asset classes
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Focused on delivering superior performance return x x x x x x x x x x x x x x x x x x x x x x x x x x x x x risk
More asset classes and diversification potential
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Focused on delivering superior performance return x x x x x x x x x x x x x x x x x x x x x x x x x x x x x risk
A ‘more efficient frontier’
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Focused on delivering superior performance return x x x x x
I II III IV V risk
MyFolio Funds – a range of investment solutions along the efficient frontier
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• Asset returns are ‘normally’ distributed variables
• Correlations between assets are fixed and constant
• All investors maximise economic utility
• All investors are rational and risk averse
•
All investors have access to the same information at the same time
• Investors have an accurate conception of possible returns
• There are no transaction costs or taxes
• All investors are price takers i.e. their actions do not influence prices
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A.
A set of portfolios that offer the maximum rate of return for any given level of risk
B.
A set of portfolios that offer the minimum rate of return for any given level of risk
C.
A set of portfolios that provide 90% returns from AA
D.
A set of randomly selected portfolios
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• Strategic asset allocation refers to the long-term allocation of an investment portfolio to various asset classes based on an investor's goals and tolerance for risk
• A portfolio's strategic asset allocation incorporates a base policy mix that should remain unchanged even when the market moves up or down
• Investments are chosen so as to:
 Maximize expected return
 Minimize risk
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The choice of asset classes can be daunting …
IL Gilts UK Equities
Cash
High Yields Bonds
Emerging
Markets
Japanese Equities
European Equities
US Equities UK Gilts
Commodities
Asia Pacific Equities
Corporate Bonds
Property
REITs
… combining them even more so
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A.
Diversification reduces risk by combining assets to reduce the overall risk to less than average risk of a single holding
B.
The downside risk of an investment can be offset by the upside of another
C.
Diversification is most effective where stocks move in opposite directions / are negatively correlated
D.
Diversification can remove non-market risk
E.
All of the above
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• Strategic asset allocation will depend on the risk profile of the investor
• Strategic asset allocation can be influenced by investor goals
• The vast majority of investors can be categorised as risk averse
• But some investors are more risk averse than others, based on characteristics such as:
 Wealth
 Gender
 Age
 Education
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• Strategic asset allocation will also depend on the investor’s time horizon

The longer the time horizon, the greater an investor’s ability to assume more risk
 Long time horizons provide more time for periods with strong performance to offset periods with poor performance
 Over a long-term investment horizon, inflation can pose a greater threat than market volatility

The longer an investor’s time horizon, the more they will be willing to invest in illiquid investments
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• Strategic asset allocation is founded on the following beliefs:

The advisor has accurately identified the client’s characteristics, hence an ideal asset allocation should be identifiable
 Market timing is impossible, hence only a long term approach is prudent
Source: The Chartered Insurance Institute, July 2010
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A.
SAA attempts to time the market
B.
SAA is a long term approach
C.
The investor’s risk profile is irrelevant to SAA
D.
The investor’s time horizon is irrelevant to SAA
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Q What percentage of the variation in a portfolio’s return is explained by it’s long term target asset allocation policy?
A.
87.5% based on latest studies from
B.
More than 100% and frequently stock (fund) selection and market timing / can destroy value
C.
At least 75%
D.
About 90%
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Driven by the level of return needed by the client and then limited by the tolerance for declines. The client has several choices:
• Adjust the goals downward until the required return has a volatility that is acceptable
•
Work longer or save more so that the need for returns can be lowered
• Die sooner!
• Learn more about investment history and concepts so their tolerance for volatility / risk increases
Source: Creating a IPS, Boone and Lubitz
Asset allocation is probably the single most important issue to be addressed by an investor and the adviser
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Company
AXA
Canada Life
Zurich
Cofunds
Fidelity
Fidelity Inv Sol
Winterthur
Friends Provident
Norwich Union
Prudential
Scottish Equitable
Skandia / Selestia
High
Low
Cash
0
0
5
0
5
5
5
16
5
0
5
0
Property
5
10
13
20
13
15
13
20
30
10
13
15
Fixed
Interest
30
40
22
12
22
26
22
24
25
50
22
39
UK Equity
30
20
29
14
30
30
29
37
29
29
29
20
Source: Produced with kind permission of Russell Investments / Paraplan Plus 2009
Overseas
Equity
10
20
31
32
35
20
31
26
31
30
31
20
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Defensive
Cash
UK Gilts
UK IL Gilts
Sterling Corp.
Total
Growth
UK Equities
US Equities
European Equities
Japan Equities
Asia Pacific Equities
GEM
High Yield
UK Property
Total
Absolute Returns
Total
Strategic Asset Allocation
%
1.0
4.5
5.0
24
34.5
2.8
5.2
2.4
8.0
17.2
10.8
3.6
2.4
52.4
13.1
100.0
Source: MyFolio III Active at 4.01.2011
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• Initial set of assets and relevant variables selected
• Long term outcomes from different investment strategies
• Assumptions are based on historic data, current market data and expert forecasts
• Sets up a projection model which looks at an entire portfolio
• Rather than setting investment returns according to their most likely estimate, it uses random variation to look at what investment conditions might be like
• Based on random outcomes, the experience of the portfolio is projected. This is repeated with new random variable thousands of times
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• Barrie & Hibbert Economic Scenario Generator (ESG) stochastically models for optimum portfolios
• Interest Rates
• Risk Premium for asset classes
• Volatility (short and long term)
• Exchange Rate Fluctuations
• Correlation
• Short Term market features that may impact long term risk/reward
Stable Portfolios – Reviewed Quarterly
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GDP projection based on market interest rate expectations and £200 billion asset purchases
Focused on delivering superior performance
Source: Bank of England, 2011
Stochastic modelling used extensively in other sections
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CPI inflation projection based on market interest rate expectations and £200 billion asset purchases
Focused on delivering superior performance
Source: Bank of England, 2011
Stochastic modelling used extensively in other sections
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Portfolio projection
Savings Account
17.5
14
10.5
7
3.5
-3.5
-7
0
-10.5
-14
Risk
Upper forecast
Mid forecast
Lower forecast
Risk of getting back less than you put in
Source: Standard Life, Portfolio Planner, 01 April 2011
2.4%
1.4%
0.8%
<=5%
Strategy Suggestion Alternative Strategy
8. Speculative to Very
Speculative
12.6%
2.0%
-9.4%
36%
6. Moderate to Speculative
10.2%
1.9%
-7.4%
34%
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European Equity
7%
Fixed Interest
9%
Far East
Equity
10%
Propert y
11%
US Equity
25%
UK Equity
38%
This can be a iterative process to determine the right portfolio mix aligns to your clients attitude to risk
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• What is stochastic modeling?
 An initial set of assets is identified
 Identify relevant variables
 Assumptions are made regarding the return behaviour of the assets, allowing for random changes in factors
 A wide range of scenarios is run in which the assets follow the assumed behaviour
 Results of these scenarios are used to determine the probability of various outcomes
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Advantages Disadvantages
Focused on delivering superior performance
• Brings rigour, logic, discipline and organisation to the investment process
• Over dependence can lead to poor decisions
•
Significant research, historic and future analysis provides deeper understanding of range of outcomes
•
Output dependant on assumptions made in any forecasting, interest rates, inflation, correlations, GDP etc.
These can vary significantly
•
Provides risk control framework, by setting minimum and maximums per asset class
•
Computer driven allocation programmes can lead to extreme allocations to certain asset classes, particular those with low or negative correlations with other asset classes • Quantitative process can help reduce any subjectivity and inconsistent approaches
•
Costs are frequently not factored into the model and these can eat into returns
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A.
A clear understanding of the expected return a client is likely to receive
B.
A range of indicative returns based on past, present and future assumptions covering a number of economic and market factors
C.
The model portfolios suggestions based on your clients attitude to risk
D.
A optimised portfolio likely to deliver above median returns
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Tactical Asset Allocation (TAA) deviates from strategic asset allocation in response to short-term expected return opportunities
 Once the opportunity is exploited, the investor returns to the original allocation
 TAA assumes that relative returns among different asset classes can diverge from equilibrium levels, but are ultimately mean reverting
 TAA enables investors to respond to significant shifts in asset price, while strategic asset allocation helps them set a long-term plan to achieve their long-term goals
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TAA differs from market timing techniques
 Tactical allocation adjustments are a form of fine-tuning to the strategic asset mix, often done in response to broader market trends
 Such deviations may be left in place for lengthy periods of time as economic or market conditions warrant
 Market timing, on the other hand, is akin to betting – its success depends on profitably gauging the size and scope of random market spikes while avoiding the equally prevalent random market troughs
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Tactical Asset Allocation working in harmony with
Strategic Asset Allocation - MyFolio Managed III
Fund
Defensive Strategic Asset
Allocation
%
Tactical Asset
Allocation
(at launch)
%
Tactical Asset
Allocation
(01/02/2011)
%
Tactical Asset
Allocation
(at 24/03/2011)
%
Cash
UK Gilts
UK IL Gilts
Sterling Corp.
Total
1.0
4.5
5.0
24
34.5
1.0
3.5
4.0
26.5
35.0
1.0
3.9
4.0
26.0
34.9
1.0
4.5
4.3
24.5
34.3
Growth
UK Equities
US Equities
European Equities
Japan Equities
Asia Pacific
Equities
GEM
High Yield
UK Property
Total
Absolute Returns
Total
5.2
2.4
8.0
52.4
13.1
100.0
17.2
10.8
3.6
2.4
2.8
6.1
5.4
8.0
51.9
13.1
100.0
17.7
10.8
1.1
0.0
2.8
5.2
5.4
8.0
52.0
13.1
100.0
17.2
10.8
2.6
0.0
2.8
5.2
5.4
8.0
52.7
13.1
100.0
17.2
11.8
1.9
1.4
1.8
Source: Standard Life Investments, April 2011, MyFolio III Active at 4.01.2011
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Q-
A.
The availability of passive index funds
B.
A long term investment objective
C.
The ability and conviction to forecast performance
D.
All of the above
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A.
TAA focuses on long-term market trends
B.
TAA is a view on market beta
C.
TAA is a core strategy
D.
TAA is a passive investing strategy
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Strategic Asset Allocation Tactical Asset Allocation
SAA means diversifying the asset allocation in order to get the most efficient Risk-Return combination in the base policy mix
The time horizon is long term in nature
It requires proper understanding of the risk and return characteristics of various asset classes and whether they are acceptable to the investor
Has a lower portfolio turnover so the transaction costs are much lower
TAA – a means to engaging in short term, tactical deviations from the asset mix to capitalise on insights
The time horizon is short to medium term in nature
It requires market timing skills
High turnover costs
Have potential to achieve high returns as there will be opportunities to beat the market
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Active vs. Passive
• Active managers primarily target a return in excess of a benchmark
(alpha)
• Passive managers seek to replicate the return of a market
Passive Management Assumptions
• Based on principle that stock markets rise more often than they fall
• Market exposure alone will generate positive returns
• Markets are totally efficient
Methods of delivery
• Full replication
• Sampling or optimisation techniques
• ETF’s
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Assumptions
Believe in their ability to deliver Alpha consistently
The concept of the efficient market hypothesis is flawed and that there
Are nearly always mispricing opportunities in the markets
Allows risk to be managed appropriately to investors
Method of delivery
Normally expressed in the asset managers investment philosophy and processes
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Techniques of active portfolio management include:
 Technical analysis: Identifies price trends in a market in order to forecast price movements
 Fundamental analysis: Identifies value of an asset as the present value of future cash flows that the asset will generate
 Quantitative analysis: Uses mathematical and statistical models in order to predict price changes
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Which of the following is more likely to describe a passive investor?
A.
Believes that markets are efficient
B.
Believes that markets are inefficient
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Q. Which investment technique is being used by an active portfolio manager in a company research visit?
A.
Technical analysis
B.
Passive investing
C.
Fundamental analysis
D.
Earnings momentum
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 Basic Modern Portfolio Theory and The Efficient Frontier
 Strategic Asset Allocation
 Stochastic Modelling
 Tactical Asset Allocation
 Passive vs. Active
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The information shown relates to the past. Past performance is not a guide to the future. The value of investment can go down as well as up.
For full details of the fund's objective, policy, investment and borrowing powers and details of the risks investors need to be aware of please refer to the full prospectus which can be found on www.standardlifeinvestments.com
Any data contained herein which is attributed to a third party ("Third Party Data") is the property of (a) third party supplier(s) (the
“Owner”) and is licensed for use by Standard Life**. Third Party Data may not be copied or distributed. Third Party Data is provided
“as is” and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner,
Standard Life** or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Past performance is no guarantee of future results.
Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates.
**Standard Life means the relevant member of the Standard Life group, being Standard Life plc together with its subsidiaries, subsidiary undertakings and associated companies (whether direct or indirect) from time to time."
Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life
Investments
(Corporate Funds) Limited, SL Capital Partners LLP and AIDA Capital Limited.
Standard Life Investments Limited is authorised and regulated by the Financial Services Authority.
Calls may be monitored and/or recorded to protect both you and us and help with our training.
www.standardlifeinvestments.com
© 2011 Standard Life, images reproduced under licence
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